Tuesday, February 5, 2013

YUM 4QFY'12 Earnings

On Monday February 4th, 2013 we purchased a half
position (55 shares) in YUM! Brands, Inc. ahead of earnings expecting better
than anticipated results. Although the company beat on revenue and EPS, the
stock gapped down due to negative guidance for FY’13 EPS. Although the company
has posted five years in a row of double digit EPS growth, the company expects EPS
to decline in the mid-single digits in 2013 y/y. This will be driven by lower sales
in China in 1H’13.

China saw a sharp decline in sales in the last two weeks of December.
On December 18th, an investigative report similar to “60 Minutes” on
CCTV (a state owned enterprise) aired related to higher than allowed antibiotic
levels for chickens in some of YUM!’s suppliers. Further investigation into
January and negative social media lower consumer confidence on KFC in the
region. After six weeks of media coverage Shanghai asked supervisory recommendations
to YUM China to improve. Going forward, management is trying to restore
confidence in their customers. YUM will be starting a quality assurance program
and marketing campaign starting after the Chinese New Year (February 10th).

In the conference call, management noted the previous adverse
PR incidents that the company has survived through including SARS, avian flu, and
ecoli at U.S. Taco Bell restaurants. For example, in 2005 YUM’s China business was
adversely affected by the avian flu, leading to a SSS decline of 40% and
operating profit decline of 5%. In 2006, SSS rebounded 26% and profit grew of
40%. Similar to their strategy in 2005, management has elected to move forward
with LT growth projections. They are not changing new unit growth for any
brands in the China region. But, there is no question they will fall short of
10% EPS growth in 2013. Management expects a mid-single digit EPS decline in
2013. Double digit EPS growth targets in 2014 and 2015.

Management has strong FY’13 expectations for YRI (YUM! International),
due to strong development momentum, higher economies of scale in certain markets
and a leading share of global emerging market restaurant exposure. SSS growth in
2013 should be similar to the 12% growth in 2012 for YRI. Russia is a prime example
of strong growth in FY’12. Russia has had highest SSS growth of any other area,
benefiting from some company owned restaurants with good returns. YUM has begun
to reach scale in France and Germany (150 and 100 total units at the end of 2012).

Results from 4QFY’12: 10% EPS growth excluding items. SSS of
YRI of 3% excluding Japan and continental Europe. Russia, Africa, Thailand, and
Korea (Pizza Hut) were standouts during the quarter. Operating profit grew 15%,
excluding the effects from foreign currency and extra week. U.S. operating
profit grew 5% y/y. U.S. restaurants are firmly positioned for more profit
growth going forward. China operating profit declined 5% prior to FX driven by
6% decline in SSS. KFC was negative in October and November, which management
affirms was due to hard y/y comps. KFC was sharply negative in December due
to the last two weeks of the month. During the quarter, KFC opened 3 new
restaurants per day (370).

January SSS decline of 41% KFC and 15% Pizza Hut. The timing
of Chinese New Year had a negative mid-teen impact on SSS. Management expects
this trend to reverse in February after the New Year. But, they estimate China
SSS decline of 25% by first quarter. After a rebound post-new year, Pizza Hut SSS
should be flat. China’s quarter only includes January and February to account
for the irregular sales around the Chinese New Year. In the first quarter of
2013, EPS will decline by 25% before special items. YRI and U.S. businesses
will remain a steady source of cash flow to the company. Excluding China, in
2013 management expects 7-8% EPS growth driven by these regions.